2003 Lane Reports

Why the Estate Tax Might Never Die

Wednesday, October 1, 2003
by Lisa A. Lehman, J.D., L.L.M. (TAX)

The California budget debacle which precipitated the upcoming recall election of Governor Gray Davis accentuates the financial woes of other states without surf and sun. In 2001, the Federal government eliminated a large source of state revenue when it enacted the Economic Growth and Tax Relief Reconciliation Act ("EGTRRA"). Specifically, the Feds reduced the states' share of estate tax revenues. To the power of cash hungry states, add a large charitable lobby which believes philanthropic contributions will significantly drop if there is no estate tax, and you have a Schwarzenegger-like muscle machine to fight the Federal estate tax repeal.

Some Background

Before EGTTRA was enacted, the federal government "shared" a portion of the federal estate tax with the states by allowing a federal estate tax credit for state death taxes paid by an estate. Most states, in turn, only imposed an estate tax equal to the state death tax credit, or a "pick-up" tax. Consequently, although the states imposed an estate tax, a state's estate tax did not increase the total amount of taxes paid by a deceased taxpayer's estate. This changed with the enactment of EGTRRA. (To see "Gift, Estate and Generation-Skipping Tax Ramifications of the Economic Growth and Tax Relief Reconciliation Act of 2001" click here) Congress, with the subtlety of a fine Napa Valley Cabernet, lowered the Federal estate tax rate …but also reduced the state death tax credit. EGTRRA goes further and eliminates the estate tax, but only for the year 2010, unless Congress acts to make the repeal permanent. This temporary repeal has fueled speculation that the estate tax is in a downward spiral to inevitable extinction. Since, in the majority of states, the state estate tax only equals the amount of the Federal credit, repeal of the Federal estate tax would also repeal the state estate tax!

The States' Budget Crises

The National Governors Association, in "The State Fiscal Crisis" 2003, stated,

"States are facing a perfect storm: deteriorating tax bases, an explosion in health care costs, and a virtual collapse of capital gains and corporate profit tax revenues."

Storm may be the wrong analogy - an earthquake seems a more fitting metaphor. Illinois has an anticipated $5 billion accumulated deficit for 2004 fiscal year. Estimates put the combined budget deficits of all states at $82 billion for fiscal year 2004. The Center on Budget and Policy Priorities ("CBPP"), citing IRS statistics, reports that California received approximately $590 million per year from 1995 through 1997 in estate tax revenue from the federal state death tax credit. Here are the other states which stand to lose great sums of money if the estate tax is repealed.

Average Federal Credit,
Calendar Years 1995- 1997
(for states with pick-up tax only)

CBPP estimates total revenue loss to all states if the estate tax is repealed in 2010 would be $9 billion per year. Those tax dollars will need to be replaced, and putting a state inheritance tax into place would be politically challenging. The Joint Committee on Taxation projects that only 2% of estates owe estate tax. The repeal of estate tax would plump up the coffers of the wealthiest Americans, such as, say, Hollywood celebrities, while reducing the state revenues available to provide benefits and services for all state citizens. As the year 2010 draws closer, the states will ratchet up their efforts to fight the repeal of the federal estate tax.

The Charitable Angle

One way to reduce the estate tax burden is by making contributions to charity. The tax law allows an unlimited estate tax deduction for gifts made to most charities. Charity is widely defined in the tax law to include publicly supported organizations, schools, medical, scientific, churches and animal welfare organizations. (To learn more about charitable gifting and read "Charitable Deductions: Tax Planning for 2001" click here)

The Urban-Brookings Institute estimates charitable giving would drop by between 22 and 37 percent, or between $3.6 billion and $6 billion per year, if the estate tax was repealed. Large institutional charities such as the Red Cross, United Way and Salvation Army can be expected to mount lobbying efforts to tide this potential loss of revenue.

What's a Taxpayer To Do?

Everyone knows it's prudent to buy insurance to cover foreseeable and significant risks. The Federal estate tax, in some shape and form, is likely here to stay. Estate planning, like insurance, provides peace of mind. Wills and trusts should be used to take advantage of the $1,000,000 estate tax exemption or "applicable exclusion amount." Annual gifts of $11,000 can be made to any number of individuals, without "eating into" the applicable exclusion amount. For more significant estates, consideration should be given to reducing estate taxes by shifting appreciation through the use of leveraged transfer vehicles. These vehicles are especially useful for interests in closely-held businesses. (For additional information on leveraged transfers, see "More Blessed - And Profitable - To Give …" click here and to see "How Family Limited Partnerships Build Wealth" click here).

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The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.

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